Banks take a hard look at lending to microfinance firms

The microfinance sector, which was considered to be recession proof, has also become a victim of the economic slowdown. The flow of bank funds into the sector is down to just a fraction of what it was just a couple of years back.

Microfinance provides banking facilities, especially credit, to the poor. Banks lend to micro finance institutions (MFIs), who pass on the credit to the unbanked.

It was a win-win situation for both parties. The MFIs got cheap funding and the banks, by indirectly lending to the poor, fulfilled a part of their priority lending obligation. (According to RBI norms, local banks must lend 40% of their credit portfolio to the priority sector, which includes rural customers).

But financial horror stories from the US and uncertainties over future funding have forced banks to check their exposure with a magnifying glass. Doubting whether the runaway growth in the microfinance sector over the last couple of years can be sustained, banks are now refusing to provide finance to MFIs without analysing the balance sheet.

So, MFIs that don’t have the systems to maintain their balance sheets can forget about getting any kind of finance. Currently only the big MFIs have the wherewithal to audit accounts and maintain balance sheets.

With funds hard to come by, smaller MFIs are finding the going difficult.
“If MFIs don’t get funds for a year they will close down and their efforts of the last 3-4-5 years will go waste. Banks must understand that our’s is a long-term business to be done for five years. If they just pull out after a year, we will have to merge or close down,” said Rakesh Dubey, chief finance officer of Allahabad-based Sonata Microfinance.

But bankers say their commitment to the microfinance sector continues. However, too much exposure won’t be good, they add.

“The MFI industry has experienced record growth in the last few years. The economic output generation that this industry had funded is to a great extent responsible for driving the unabated growth in the rural economy,” said Kumar Ashish, general manager at ICICI Bank who is in charge of the microfinance business. “(But) There is a need for these organisations to temper their growth and focus on building strong foundations for controls and systems, on which they can grow their organisations further.”

Kumar says the fast growth has brought in new challenges that involve transition from small institutions needing home-grown policies and technology solutions to running complex multi-state organisations employing thousands, without sufficient controls.

“One can empathetically say that most MFIs haven’t had the time to spruce up their controls to match their rapid growth. This is potentially dangerous,” he said.

Fellow banker and head of microfinance and sustainable development for Royal Bank of Scotland in India, Moumita Sen Sarma, said a slowdown in microfinance would be welcome. “If there is a slowdown in growth of MFIs, it will allow them to focus on strengthening their systems and processes. Out risk appetite will be lower for MFIs that are not following robust systems and processes,” she said.

RBS has recently launched toolkits that help MFIs audit and put MIS systems in place.
Some MFIs remain confident despite the fund crunch.

Titus Mathew, executive of SaDhan, an association of community development finance institutions, said banks choosing to be more cognizant shouldn’t be a problem. “The emphasis on asset quality is a good thing for the asset class. Growth is going to be toned down in 2009-10 versus 2008-09 because we are growing into new markets and there has been a liquidity squeeze because the RBI’s rate cuts haven’t yet transmitted fully,” he said.

Mathew expects growth to be at least a few percentage points lower than the 70%+ growth seen last year.

There are also some lifelines for the MFIs.

Investment bankers like Intellecap and Grameen Capital are helping them get both debt and equity funding to build their books and then approach banks for funds.

Moreover, there have been a few deals in which banks such as IndusInd Bank, Yes Bank and ICICI Bank have provided advances to MFIs such as Bandhan and SKS for agricultural and allied lending. The MFIs have to administer loans and channel the collections to the bank.